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Hypocrites? Why CDS-Insured Greek Bondholders Aren't Getting Paid

Credit default swaps (CDS) have once again been thrust into the general public’s attention, as the International Swaps and Derivatives Association ruled that as of Thursday, the Greek debt restructuring hadn’t triggered a “credit event.” In other words, Greece hasn’t defaulted, yet.

While some may ask themselves why we’re spending so much time talking about Greek CDS, given net notional value of CDS outstanding on Greece is around $3.2 billion and thus doesn’t pose systemic risk, it is defining moment for the CDS market. As things stand, it does seem like the Greek restructuring will indeed trigger some CDS in the near future. The story is quite complicated, though.

Credit events, or defaults, are determined by a 15-person committee upon receipt of a question regarding a specific contract, in this case, relating to two different series of Greek sovereign bonds. It’s important to note that the committee is made up by major Wall Street names including Goldman Sachs, JPMorgan Chase, and Morgan Stanley, along with big European names like Barclays, BNP Paribas, Societe Generale, Deutsche Bank, and asset managers/hedge funds like D.E. Shaw, Citadel, and PIMCO.

No matter what the ISDA says, conflicts of interest are unavoidable. For example, after the ISDA’s announcement on Thursday, PIMCO founder and co-CIO Bill Gross criticized the decision, saying it set a “dangerous precedent,” according to Reuters. Gross was essentially saying that while it is perfectly clear for anyone that the write-down (and approximately 70% haircut) on Greek sovereign bonds should be considered a default, it wasn’t being ruled as one by the governing body. Note that PIMCO voted in line with every other member of the committee.

So what’s going on?

CDS are over-the-counter instruments governed by contracts signed by parties involved, they constitute what could be called a private market. Thus, while it may appear ridiculous to some that what is clearly a default isn’t being considered one, it is in the ISDA’s full right to do that. As an ISDA spokesman told me, if you don’t like it, don’t buy CDS.

At the same time, CDS aren’t cheap hedging tools that retail investors generally have access to, as a former CDS trader for a major bank explained. “It’s very hard,” he said “even for hedge funds with $30 million [under management] to hedge with CDS.” At the end of the day, CDS are tools used both for hedging and speculating. According to the trader, the speculator is being screwed at the expense of the hedger, or the larger institutions.

Looking a bit more closely at the specifics of the Greek situation, the ISDA spokesman explained that its harder to draw a line in the sand when we are talking about sovereigns, as compared with private firms where determining a bankruptcy is quite simple. In terms of Greek CDS, the problem hinges on the definition of “voluntary.”

The Greek PSI or restructuring deal was designed to avoid triggering CDS contracts (former ECB chief Jean Claude Trichet once said defaults were “taboo”). Thus, private bondholders were told the debt swap was “voluntary,” despite being forced to take a 70% haircut. If you have CDS protection that would pay in the case of default, why would you take the haircut? Because politics is the name of the game, and as an analyst at a major investment bank told me, “European governments can exert a lot of influence.”

If bondholders were to voluntarily swap their bonds, there would be no credit event. The problem is some Greek creditors, presumably the speculators and smaller players, are expected to hold out, and if the Greek government doesn’t achieve a 90% rate, then the second bailout (which is what this is all about, at the end of the day) will be called off.

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Once Goldman got bailed out by the Fed they should have lost the right to arbitrate at least previous agreements. Bring back regulations for these twirps that do not have any desire to operate in “good faith”. It is not enough Goldman operate like a casino with odds in their favour but now they do not admit to the obvious. These guys are not moraly fit to operate a hot dog stand.

The problem with the moral dilemma in CDS is that it’s a private market. It’s not like the stock market (which, to a certain extent, is also private, but a lot bigger). It’s an opaque market that operates for itself (the major players are also those voting to determine what’s a default).

If the the mortgage CDS market is private as you say the why did the Federal Reserve print TRILLIONS of dollars to pay off every mortgage CDS held by every bank and investor 100 cents on the dollar in every country in the world with American taxpayer debt. That does not sound like a “private” market to me.

It’s private in that it isn’t regulated by Federal authorities, both in the US an internationally. Rules regarding CDS are established by the ISDA and by contracts signed by participating parties, they are over-the-counter.

Despite this being a private market, it has an effect beyond that private market, and thus would’ve taken AIG and much of the financial system with it if the Fed, Treasury, and others didn’t act.

Was there a Greek default? Are you going to believe the ISDA or your lying eyes?

Seriously, why will players come to the table if they know the game is rigged?

In life you have to know where you stand in the food chain, and the insiders (Greek government, the Troika, and the major financial institutions) have told investors that they are big enough to bet (ie put money into the pot), but they are not big enough to win.

Currently, Greece has managed to avoid a default. And given how much effort Germany and its Troika friends have put into this, I have a feeling they will help Greece avoid missing a payment. The thing is, though, that a restructuring is also a form of default. This one comes with a 70% haircut (net present value), and it’s there where the ISDA will jump in and interpret its own rules in a way that allows them to avoid a credit event.

Regardless, the announcement we got just said that for the moment, there hasn’t been a credit event. If, as is expected, Greece is forced to use CACs to bring hold outs on board, then it seems hard even for them to pull another rabbit out of the proverbial hat and claim there was no default (recall that these CACs were retroactively inserted).

Greece confirmed that it had achieved an 85.8% participation rate on its debt exchange just short of the required 90+% rate. So would this amount to calling off the whole deal as such? would’nt that then send the financial alarm bells ringing ?